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Economics

Study Notes

Business Objectives and Consumer Welfare (Chain of Analysis)

Level:
A Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Here is an example of writing chains of analysis to this question: "Analyse how a change in business objectives might affect consumer welfare in a market."

Standard theory assumes that businesses aim to set price and output where MC=MR. This is where profits are maximised and might be linked to the aim of increasing shareholder returns.

A shift in business objectives can change consumer welfare. For example a business might seek to maximise their total revenue at an output where marginal revenue is zero.

As a result,the equilibrium price charged will fall. This is shown in my analysis diagram as a fall in price from P1 to P2. This assumes no shift in the AR and MR curves (i.e. ceteris paribus).

The effect of this is to cause an expansion of demand as a lower price increases the effective demand / real income of some consumers. Prices fall but the level of supernormal profit declines.

One consequence of this can bethat consumer surplus increases. Thisis a measure of consumer welfare. If prices are now closer to marginal cost, then this is a gain in allocative efficiency.

The impact of a move to revenue maximisation is likely to begreater if demand is price elastic. This means that slightly lower prices will then attract price-sensitive consumers into the market.

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